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Ifrs 36Edit

IFRS 36 Impairment of Assets is a central component of the international framework for financial reporting. It governs when and how the book value of a company’s non-financial assets—such as property, plant and equipment, intangible assets, and goodwill—must be written down to reflect a recoverable amount. The standard is grounded in prudence: it asks entities to avoid overstating asset values and to align the balance sheet with an asset’s true economic worth. This matters for investors, lenders, and managers because it shapes earnings, capital allocation, and debt covenants. At its core, IFRS 36 requires a careful assessment of whether the carrying amount of an asset or cash-generating unit is sustainable given current and expected future performance, and it specifies how to measure recoverable value and handle reversals when conditions improve.

The standard sits at the intersection of accounting rigor and business practicality. While it aims for transparency and comparability across jurisdictions that follow IFRS, it also imposes measurement demands that can be costly and judgment-intensive. For a right-of-center audience, the emphasis is typically on clear valuations, discipline in capital budgeting, and the importance of market-tested numbers over rosier projections. IFRS 36 aligns with a worldview that capital markets should reward true economic performance rather than façade earnings, and it provides a framework meant to prevent the overstatement of asset values that could mislead investors and creditors.

Overview

Scope and objective

IFRS 36 applies to most non-financial assets, including goodwill arising from business combinations. It requires entities to assess at each reporting date whether there are indicators that an asset may be impaired, and to estimate the recoverable amount when indicators exist. The recoverable amount is the higher of fair value less costs of disposal and value in use. If the asset’s carrying amount exceeds its recoverable amount, an impairment loss is recognized in profit or loss. Practically, this ties asset valuations to market conditions and to the entity’s own expectations about future cash flows.

Key concepts

  • Recoverable amount: the more conservative benchmark that prevents overstatement of asset values. It is measured as the higher of:
    • Fair value less costs of disposal (often reflecting market-based pricing)
    • Value in use (the present value of future cash flows, discounted)
  • Value in use: the discounted future cash flows expected from the asset or cash-generating unit, reflecting time value of money and risks specific to the asset.
  • Cash-generating unit (CGU): the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets. Impairment testing often hinges on CGUs rather than individual assets.

Recognition and measurement

  • Indications of impairment: both external (market declines, economic downturns) and internal (obsolescence, physical damage, worse-than-expected performance) signals can trigger the impairment test.
  • Calculation of impairment losses: if carrying amount > recoverable amount, impairment loss = carrying amount − recoverable amount. The loss reduces the asset’s carrying amount and is recognized in profit or loss.
  • Reversals: impairment losses for most assets can be reversed if estimates subsequently improve, but there is an important exception: impairment losses recorded for goodwill are not reversible.
  • Discount rates and inputs: value in use relies on pre-tax discount rates reflecting market assessments of time value and asset-specific risks. Inputs should be realistic and supportable, with disclosure to aid users in assessing the sensitivity of reported numbers.

Disclosures and governance

IFRS 36 requires disclosures that help users understand the impairment process, including the events that led to impairment, the methods used to determine recoverable amounts, the key assumptions, and the sensitivity of outcomes to changes in those assumptions. In practice, this information supports disciplined governance and allows analysts to compare asset performance across entities and industries.

Practical implications

  • For investors: impairment outcomes can signal shifts in a company’s asset base and long-term profitability. Large impairments may indicate strategic missteps or cyclical pressure, while reversals (where allowed) can reflect improving conditions.
  • For management: impairment testing imposes disciplined budgeting, scenario planning, and justification of the asset base. It can influence capital budgeting, asset sales decisions, and interactions with lenders.
  • For lenders and auditors: impairment judgments affect debt covenants, credit metrics, and the level of assurance provided by auditors. The clarity and consistency of assumptions become important audit considerations.

Interplay with other standards

IFRS 36 intersects with other IFRS standards. For example, impairment considerations may arise in the context of business combinations under IFRS 3, affect depreciation and amortization schedules, and interact with disclosures required by IFRS 7 and other reporting standards. The overall framework seeks to align asset valuations with economics and to ensure consistency in financial statements across periods and jurisdictions.

Controversies and debates (from a market-prudence perspective)

  • Subjectivity and management bias: impairment testing relies on forecasts of future cash flows, which can be influenced by managerial optimism or pessimism. Critics argue this introduces judgmental bias, potentially distorting reported earnings. Proponents counter that robust governance, independent assumptions, and sensitivity analyses mitigate these risks and promote more credible reporting.
  • Procyclicality of earnings: impairment losses often accelerate in downturns, depressing earnings when profits are already stressed. Critics say this can worsen market volatility. Supporters contend that recognizing impairment when recoverable amounts shrink prevents overstatement and preserves long-term capital discipline.
  • Reversals and goodwill: allowing reversals for most assets but not for goodwill can be debated. Some view reversals as desirable to reflect improving conditions; others see them as enabling earnings management. The blanket non-reversibility of goodwill impairment is defended on grounds that goodwill represents acquired, intangible value that is less amenable to precise recovery estimates.
  • Costs of compliance: the impairment framework can be costly for smaller firms and may demand sophisticated models and audits. From a market-focused stance, the cost is justified by improved transparency and comparability, which helps efficient capital allocation. Critics advocate simpler, less burdensome approaches, arguing that smaller entities should not bear outsized reporting costs.
  • Model choices: value in use requires discount rates and cash flow projections that can differ markedly between entities. Critics suggest that market-based measures (fair value) should dominate, while supporters argue that value in use captures the asset’s unique earning potential and risk profile more faithfully, especially in markets with liquidity constraints.

See also